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Weekday Trader

Gutsy Investors See Value in Latin America

By

Vito J. Racanelli

Sept. 10, 1998 11:59 p.m. ET

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If you think things are bad in the U.S., just take a look at the battered, beaten and bloodied markets south of the Rio Grande.

As late as midyear, Latin American stock markets were down a relatively modest 3% to 17%. That was no great shakes, but it was much better than the carnage and full-scale capitulation that already had swamped other emerging markets in Asia and Russia.

But that was then. In the last few weeks, Latin American equities have plunged on the same worries that hurt Asia: higher interest rates, currency devaluations, worsening corporate performance and economic slowdowns across the continent.

As of Wednesday's close, Brazil's Bovespa Index was down 45% and Argentina's Merval Index had plunged 49%. Mexican shares have fallen 39%, while Chile was off 40%. On Thursday, Latin American markets gave up even more ground -- the Bovespa plunged another 16% -- in sympathy with sliding U.S. markets. (Last year, Latin America funds returned an average 25%, according to Lipper Analytical services.)

"The fundamentals are deteriorating.... It's crunch time," says Jane Heap, the Latin American strategist for Deutsche Bank Securities, which last week cut its projections for economic growth in 1999 for seven Latin American countries. Brazil, for example, should now experience 1% growth next year instead of 2.5%, she says, (That's about the same as her predictions for this year.) In recent days many Wall Street brokerages have similarly chopped their economic growth projections for Latin America.

And there may well be more downside risk in these markets. If Brazil devalues its currency, the real, Argentina and other countries could follow -- and you can toss even the reduced growth estimates out the window, warns Heap. As Weekday Trader pointed out recently, fear and negative sentiment are likely to overshadow the fundamentally sound changes -- free markets, low inflation and improved democratic institutions -- that have spurred "tiger-like" growth in Latin American countries in recent years (See "Latin Markets Don't Have Much Bounce Left ," June 18).

Nevertheless, with nearly all Latin American markets in full retreat, certain defensive stocks may begin to look attractive even if the markets' bottom is nowhere in sight. After all, people will still make phone calls and quaff soft drinks in a severe bear market or economic recession, some are beginning to say.

And while its growth will likely slow, Latin America doesn't have the serious structural problems afflicting Japan, Russia and Southeast Asia. For example, while Malaysia imposed strict currency controls, Brazil's government -- in an election year, no less -- said it would continue to cut the budget deficit this year and next.

It's unclear if that will be enough to stave off devaluation, but the country is moving in the right direction, notes Paul Stocking, senior Latin American analyst for American Express Asset Management. And if South American countries like Brazil can avoid devaluations and ruinously high interest rates, economies might grow more slowly -- but they will continue to grow, says Heap.

Now, make no mistake: Few if any strategists or analysts are pounding the table for these stocks. Though Stocking isn't about to predict a bottom for these markets, he is willing to say that "on a fundamental basis there is a strong argument that they [Latin American stocks] are oversold." And Heap feels more bullish about Latin American equities 18 months from now.

So does James Barrineau, the area strategist for Salomon Smith Barney, who says these markets may need to fall even further before they find a bottom. But, he adds, "if you have a longer time horizon, then there are cheap stocks."

Where? Barrineau prefers liquid stocks that have reliable earnings. All of the region's telecommunications stocks have gotten crushed, and "if you have a scenario where the dust settles, then Mexico is poised to perform the best," he says. (Unlike most Latin American currencies, Mexico's peso is free floating. So while this week Brazil has been hiking rates to defend the real and Colombia effectively devalued its currency, Mexico is likely to have more stable interest rates.)

For those reasons, among others, both Barrineau and Heap like
Telefonos de Mexico SA,
or Telmex, the country's dominant carrier. At Thursday's close of $33 1/4 -- a new 52-week low and 43% off their 52-week high of 58 7/16 -- the shares sell at about seven times First Call's consensus estimates of $4.59 per ADR in 1999. That's around 10% higher than the estimated $4.16 this year. Wall Street is looking for annual earnings growth of 15% for Telmex over the next five years.

Heap also likes
Telefonica de Argentina SA,
one of Argentina's two big telecom carriers, which covers the southern half of the country, including the capital of Buenos Aires. At Thursday's close of $19 3/4 -- also a new 52-week low and 50% off their 52-week highs -- Telefonica's ADRs change hands at less than seven times First Call's consensus estimates of $2.88 per ADR in 1999. That's 12.5% ahead of this year's estimated $2.56; analysts project annual profit growth of 13% over the next five years.

Even those who think the worst may be over suggest treading carefully. American Express's Stocking advises investors to avoid financial stocks, which he says are essentially leveraged country plays, because of their exposure to rising interest rates. Of course, commodity stocks and basic industries -- which represent a big chunk of Latin American markets -- are also likely to underperform, other analysts say.

Clearly, Latin America will remain a volatile and risky place to invest for some time. The bottom might not come soon, but when it does, stable market leaders like Telmex and Telefonica will likely be at or near the top of investors' shopping lists.

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